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US – after the election...

Ahead of the curve

The US Fed will remain the test case for whether any central bank can ‘normalise’ interest rates. We expect it to try, but fail – regardless of who is US President. And, even the volatility that could accompany a Trump-led paradigm shift (which is our risk case) does not point to an aggressive Fed. Neil Williams, Group Chief Economist at Hermes Investment Management, discusses the macro implications of the Presidential election in his November Ahead of the Curve.

Macro implications of the Presidential election...We set out the Presidential candidates’ main macro differences. Our table below, which is intended to be illustrative rather than exhaustive, summarises them. Secretary Clinton’s proposals are stimulatory, but closer to the status quo. Mr. Trump’s likely, more front-ended fiscal splurge would be muted by the threat of protectionism, and the possible hit to US asset prices.

First, US debt and fiscal policy. Neither candidate expresses urgency for fiscal contraction, citing growth enhancement, albeit via different channels, as the main priority. Trump promises a virtually unconstrained fiscal splurge and domestic growth-focus (lower trade dependence, migration cuts) to achieve a 3½%yoy real growth rate within the next decade. Clinton advocates a more evenly spread-out stimulus, and thus a more sustained GDP-lift.

Raising the $18.1trn debt ceiling will be first test for the new administration...However, the stock of net debt remains high, at 90% of GDP. And the highly visible ‘debt ceiling’ - which sets the theoretical cap on government financing, is a record $18.1trn. Extending it out to 15 March 2017 eased obfuscation in election year, but now leaves it as first test of the new administration - especially as fresh commitments have since unofficially breached it, to $19trn.

It may be easier for Trump to delay raising it further, blaming it on his Democrat predecessor. However, unless dealt with effectively, the threat of government shutdown, unpaid obligations, and default risk would offer an additional route to the recession already implied, ahead of the 2018 mid-term elections, by the US Treasury curve. In practice, ‘default’ is likely only indirectly via inflation, given all the debt’s denominated in US dollars. Yet, if akin to previous shutdowns, such as August 2011, equities and US sovereign ratings could again suffer.

Trump would have to water down his proposals to get them past Congress...Second, Congress would also oppose his aggressive anti-trade proposals, including 45% and 35% tariffs levied respectively on China and Mexico, and a review of NAFTA. The risk is he enacts ‘Super 301’ (section 301 of the 1974 Trade Act) to impose tariffs without Congressional/WTO approval on countries engaged in “unfair” trade practices.

In which case, expect a broadening to other countries whose ‘cheaper’ imports then fill the gap (e.g. EMs), global retaliation, and a flow-back from Mexico (which relies on the US for 80% of its exports and the bulk of remittance inflows), a likely China currency devaluation, and Canada. Clinton’s become more equivocal on free trade - which needs watching - but is closer to the status quo.

As she is on immigration, her plan supports Senate legislation passed in 2013, whose ‘path to citizenship’ would, according to CBO estimates at the time, increase the labour force by about six million over a decade. By contrast, Trump’s threats to ring-fence Mexico (literally), and increase the deportation of illegal immigrants (intended to be 11.3 million over two terms, 7% of the workforce, or 3-4 times the maximum achieved per annum under Obama) would, unless offset, surely accelerate the shrinking labour supply, and cut potential growth.

The wrong sort of inflation...The cut to the labour pool from Trump’s policies could admittedly provide a spur to wages needed to re-steepen the Phillips Curve. Yet, the hit to consumers and firms from the cost-push inflation that protectionism spawns suggests any demand lift from a more isolationist US would probably be short-lived. In which case, the FOMC would be loath to hike again.

Meanwhile, a new global risk emerges. Rather than the financial distrust in 2008’s crisis, markets may increasingly need to brace for political distrust, given the risk of beggar-thy-neighbour policies - from the US election to an upsurge of anti-European populism - is increasing.

In which case, without care, an unhelpful jigsaw piece that prolonged the 1930s depression, but was largely absent from 2008 - retaliatory trade protectionism - might yet come crashing into place.

Neil WilliamsGroup Chief EconomistNeil joined Hermes in August 2009 and is responsible for Hermes’ economic research. He has a forward-looking approach to generate investment strategy ideas. Neil adopts top-down methods – macro and market analysis to identify interest rate and credit value, and sovereign default risk. Neil began his career in 1987 at the Confederation of British Industry (CBI), becoming its youngest ever Head of Economic Policy. He went on to hold a number of senior positions in investment banks - including Director of Bond Research at UBS, Head of Research at Sumitomo International, Global Head of Emerging Markets Research at PaineWebber International, and, before coming to Hermes, Head of Sovereign Research and Strategy at Mizuho International. Neil has 29 years’ industry experience and earned an MA in Economics in 1986 from Manchester University, having the previous year completed his BSc (Hons), also in Economics, from University College Swansea. Read all articles
by Neil Williams